When a business starts sliding toward insolvency, choosing the right restructuring path can make the difference between salvage and collapse. Two paths often come to mind: Business Debt Settlement and Chapter 11 Bankruptcy. Settling means negotiating with creditors out of court; Chapter 11 means restructuring under the Bankruptcy Code with a judge watching. Both are meant to get the business back to profitability. So how do you decide which route to take? That depends on some important facts about your business, and every company’s circumstances are a little different. Negotiating a consensual workout is ideally better than the formal bankruptcy process. But can you swing it? The answer turns mostly on cash.
How Much Cash Does Your Business Have
Chances are, if your business is teetering, you’re worried about being forced to cease operations because you can’t meet your monthly obligations. So how much cash does your business have, and how much cash do you expect to generate each month? How much money will it take to keep the lights on and continue operations? Even a quick, cheap settlement can be a problem if you’re short on cash. In addition to needing cash to stay in business, you’ll also need cash to create a viable restructuring plan, and time to negotiate it. If the money will run out first, the company will most likely have to start in bankruptcy court.
The second question is how many creditors you have. The catch is that everybody has to say yes. With a so-called workout, nothing happens without the consent of all the involved creditors. If you have only a few creditors, this is more practical. The more lenders, vendors and suppliers who are owed money, the greater the chance they won’t all agree to save the company, and the company will likely have to surrender to Chapter 11 and ask for protection.
The third question is how well you get along with the people you owe. Banks, lessors and major suppliers all have to agree on what went wrong and how to fix it. When the relationships with creditors are positive, and the interactions are mutually beneficial, the negotiation is easier. If you have friendly creditors who know you want to move forward, then you might have an easier time. If, on the other hand, creditors are not eager to conspire to help the company, then it might be best to see the court.
Settling Out of Court
If a settlement is within reach, it has real advantages over Chapter 11. The first is cost. Chapter 11 comes with court fees, legal fees, administrative costs, and so on. A consensual settlement, on the other hand, is relatively low cost. It takes time to reach a deal, and there are legal fees and negotiation time, but nothing compared to the bankruptcy process. Another benefit is that in a workout, a company is not shackled to a judge. You are free to propose whatever plan gives the business its best shot at growth and profit.
The second advantage is time. Most out-of-court deals are done in six to nine months, sometimes sooner. A Chapter 11 case usually takes nine to twelve months, and every one of those extra months costs the company money.
The third benefit is discretion. A workout remains completely between the company and its creditors. There is far less financial reporting than in a bankruptcy case. The paperwork stays out of public view. Fewer people know about the trouble, so there is less to rattle employees or trade creditors.
The last advantage is harder to measure. If your creditors agree to settle, it says something about their confidence in you and your ability to successfully remedy the problem. They believe you can make it work. If they stick with you, they’re betting that your firm has taken a temporary hit. If they did not trust you, they would probably reject a workout in favor of the bankruptcy process.
The price of settling out of court is that you give up the protections bankruptcy offers. While you negotiate, no automatic stay protects you against collection efforts. Creditors can still demand payment on old debts and sue. In short, you are vulnerable to legal action or retaliation until you settle with all creditors. Your agreement depends entirely on your relationship with all creditors and your ability to convince each and every one to compromise.
Chapter 11 Proceedings
None of this means Chapter 11 is a bad choice. Bankruptcy gives a struggling company some powerful tools that it simply cannot get by negotiating on its own. The most important is the automatic stay. The moment the petition is filed, all collection activity is immediately prohibited. This allows the ailing company time to plan its next steps without having creditors breathing down its neck. The litigation is put on hold.
Chapter 11 can also be the better choice when the business cannot survive in its current form. If the numbers show the company is not viable as it stands, creditors are likely to demand a hard look at whether the company can reorganize. Many will prefer to deal with it inside Chapter 11, where the court’s protections cover them too. In that case, the best way out may be to sell the company, and a buyer will find it much easier to acquire the company in bankruptcy. The buyer can get clear title with a court-ordered sale, free of liens and old claims against the company’s assets.
Similarly, if the company has particularly burdensome obligations that it cannot resolve out of bankruptcy, then filing for protection may make the most sense. For example, if the company has high rent payments that are dragging it down, the bankruptcy judge may allow it to reject the lease. Leases are not the only contracts that can be rejected. License agreements, franchise agreements and equipment rentals are other executory contracts a company could not otherwise walk away from, and in retail bankruptcies the savings can be substantial.
Then there is the judge. When a bankruptcy court confirms your plan, it gives it the final stamp of approval. Outsiders will all respect the judge’s decision that your plan is fair and balanced. Because a judge has gone over the details, the company is better placed to present itself as viable.
That’s not to say there’s no downside. Even when a Chapter 11 case can save your business, the costs of the fight will likely be higher. The bankruptcy is also more public. You will be paying extra in fees, legal costs and court costs. In practice, Chapter 11 proceedings are quite intrusive. There are constant financial reporting requirements in bankruptcy court. Every month, the company must open its books and disclose a monthly operating statement. Budgets are required too. Public records allow anyone to track the company’s finances month by month. The case also moves more slowly, because federal courts insist on formal procedure. Negotiating in bankruptcy is different, with third parties all looking over your shoulder. The case is run by a U.S. bankruptcy court under strict rules that everyone involved must follow. Court proceedings leave less room for the flexibility that every situation requires.
Chapter 11 is not necessarily a worse choice, but it is different. Both out-of-court workouts and Chapter 11 cases are designed to revive a failing business, but different factors drive the decision. Finding the right path between Chapter 11 and out-of-court negotiations should be a conscious choice based on facts that are unique to your situation. By understanding your business – how much money you have and how much you need, who you owe, and how good a track record you’ve got with all these creditors – you can make the most appropriate call, and either road can lead to a turnaround if you act early and with a plan.
